IT'S ONE thing for the US Treasury Department to overpay banks for their toxic assets on the prayer that bank shareholders will do something besides pocket it - something that will help the economy. It's another thing to set up a complex leveraged auction scheme to surreptitiously make the transfer. And it's yet a third thing to set up a scheme that will lead the banks to overbid for their own toxics to garner even larger windfalls and end up with the toxics still in their hands.
Suppose the government tells the market that it will match dollar for dollar bids to buy a toxic asset called Troubled from Seamy Bank. Absent the subsidy, Troubled would be worth $1 billion - only 20 percent of its $5 billion face value. With the subsidy, bidders will offer $2 billion since their net cost is just $1 billion, which is Troubled's true value. Seamy Bank's profit from the "sale" equals $1 billion (the $2 billion it receives less the $1 billion it hands over in the form of surrendering title to Troubled.)